September 2024

Dear Client:

Enclosed are your portfolio reports for the quarter ending March 31, 2024. We also enclose a separate schedule of portfolio performance statistics. In summary form, the total return changes in the broader stock market and price changes in the bond market in the quarter appear below:

	3/31/23	12/31/23	% Change
Stocks (S&P 500 Index total return)	11,418.03	10,327.83	10.56
Bonds (U.S. Treasury 4.125% due 11/15/32)	$99.32	$101.65	-2.29

The above schedule shows bonds continuing to struggle. They fell in price over full-year 2023, and 2022 was the worst year for bonds in American history. Banks, utilities, commercial real estate, insurance, and other sectors whose businesses particularly depend upon bonds face big problems related to inflation, which we will discuss.

Stocks were another story last quarter. The size-weighted S&P 500 stock average was up strongly, and this after a banner year in 2023. Admittedly 2022 was a disaster for the S&P 500, down 30% in price; but that painful episode seems now all but forgotten. The performance of the S&P 500 was so good last quarter that it raises an important question for stock investors, which we will consider at some length.

Since a careful and selective investment strategy has lagged the index—which has continued to be driven by the returns of a dwindling handful of tech stocks—should we be getting more aggressive and chase those returns? That was also the question through most of the 1990s when Internet and high-tech stock sectors rocketed up, year after year, in defiance of all warnings to the contrary; and yes, it is the dilemma now as a handful of super large stocks pull the rest of the stock market along behind them to new all-time stock height. Although there are some signs that the market rally is broadening (an equal-weighted S&P 500 Index outperformed the market-cap weighted Index in March), it’s still the big tech behemoths that dominate the news. Twenty-two times last quarter the S&P 500 Index notched new all-time heights. And the answer to the important question? Much depends of course on what is meant by terms like “careful” and “aggressive” and what is going on in the rest of society. I would define “careful” as doing what you already know because it has generally worked in the past and you more or less understand why, and “aggressive” is what you understand less well but use anyway because it seems to be working. There is heavy reliance on luck. Back in the late 90s almost any caution on the part of investors (as, for instance, wanting to see products, sales and profits before buying a stock) meant missing out on big gains; for investment management firms like O’Brien Greene & Co. it meant that and more—caution also meant losing clients. Caution looks like lack of imagination or even incompetence when the bulls are running, and any comfort that caution might give turns out to be small and temporary when friends and neighbors are making money, and the client is not. I remember an older gentleman, normally a very cautious investor, urging us in the late 1990s, right at the peak, to get more aggressive with his IRA, “just for a little while.” The cautious approach (including our own) tended to underperform the large cap, tech and telecom-heavy stock averages in the late 90s, but when the reckoning came in the early 2000s, the cautious approach began a decade-plus of outperformance. We expect a similar dynamic is in process now, for reasons we will explain below. But first a few words on the stormy present and why we think the time is especially unripe for aggressive risk-taking.

Empty office buildings across the nation illustrate a persistent problem in the commercial real estate market since the pandemic; in center city Philadelphia office occupancy rates are under 40%. The remote work phenomenon compounded by political and social upheaval in major cities make the future of commercial office properties and the billions of debt attached to them look increasingly at risk of major write offs. The highest inflation in 40 years has cooled somewhat but is showing signs of reacceleration, even as annual budget deficits and soaring public debt are growing at unprecedented rates amidst full employment. An inflationary wage-price spiral has been tamped down by massive immigration, legal and illegal, which has helped to inflate already nosebleed housing prices and destabilize many local communities. Sclerotic political leadership characterizes both political parties, foreign proxy wars rage in Ukraine and Gaza, and major geopolitical realignment in central and east Asia is disrupting the previous forty-some years of globalization. There would appear more reasons now than in the 1990s for caution. At the same time, there is every reason to stay invested, as there was in the 1990s, because the opportunities are great, as they were then, and inflation is worse, a lot worse. The matter is how best to stay invested. While any of the contemporary dangers mentioned above is beyond our power to control and predict, we should not lose sight of our power to make even the biggest of them worse. I am speaking of the unintended transformation of a public sector crisis into a personal one through self-inflicted investment wounds.

I have observed that people harm themselves when they neglect what they already know. It is not ignorance, but neglect, which is a very different state. But in that difference lies a remedy. With a little attention to the occasions of the self-inflicted wound, and regular practice,¹ you can avoid the worst ones, stay in the game, and ultimately reap the full benefits of long-term investing. Let me suggest six lessons that we know, or think we do, that must be frequently explained to be retained:

1. At the very top of the list, though it just arrived there, is something we often heard as kids: don’t talk to strangers, especially if it is over the phone or email. Everyone knows this, but for some reason it is happening anyway to the owners of investment accounts—account hacking, spoofing, phishing is an epidemic. The cleverness of the scams is amazing, and with the advent of artificial intelligence is likely to get worse. While we are waiting for technological precautions to improve, we would simply not talk to strangers over the phone about where you live, work, or bank in the knowledge that personal information might be taken to defraud you. If you wish to discuss reasonable security measures you can take, and the ones we already practice at O’Brien Greene, please give us a call.
   

2. We read the financial media closely and know the various services compete to tell us what to think and how to act on monetary and fiscal policy, artificial intelligence, remote work, energy self-sufficiency and sustainability, and the rest of the future. All very exciting. But it may be better to start an investment review with what in some circles is called the “lifeboat drill.” It asks how you would feel about stocks—including your stocks—going down 50% in value overnight. Such a turn of events is entirely possible. Do stock prices come back? Yes, except for bubbles, which I will discuss below, stocks always have come back, but it can take time, as much as ten years, and after a while people tend to say, “I don’t need this; I would rather worry about something else,” and they sell, usually at the bottom. So perform the lifeboat drill often to make sure you are prepared for what owning stocks means, which is volatility, remembering that this volatility is the price worth paying for fractional ownership in productive businesses—a better long-term store of wealth and engine of growth than cash in the mattress. What if official government metrics indicate otherwise—that the coast is clear because inflation is coming down, corporate profitability is picking up, employment and personal income rising and debt falling? Are such metrics more reliable, trustworthy—“actionable”—than the lifeboat drill? We would be reluctant to base important investment decisions on official statistics or statements regarding inflation, employment, housing and myriad other economic measures. The reasons why are the subject for another report.
   

3. I mentioned bubbles; they can cause enormous and permanent destruction of wealth. A very few, but famous, Wall Street operators actively seek out bubbles and have demonstrated the ability to make enormous amounts of money from them, but for the vast majority the experience of those few is highly misleading. A handful of Internet companies survived the 1990’s bubble, but dozens and dozens were completely wiped out. Fortunately, bubbles are relatively rare, but they play no role in a cautious investment approach. A soaring stock price unaccompanied by profits—the condition that a former Federal Reserve chairman called “irrational exuberance”—usually means stay away. There is a lot of discussion at the present time whether we are in an artificial intelligence (AI) bubble. A lack of profits isn’t the case for Nvidia, the semiconductor company which is the poster child of AI beneficiaries. However, there are other features of its recent success which eerily parallel the boom-then-bust fortunes of late 90s Internet infrastructure beneficiaries like Cisco, Corning, or Qualcomm. Hardware investment cycles can whipsaw viciously, and there are some signs that Nvidia’s concentrated customer base (Facebook, Google, Microsoft, Amazon) may already be overordering its semiconductors out of competitive speculation rather than to meet fundamental demand. The absence of Nvidia’s insiders buying their own stock suggests that the AI craze took management by surprise as much as it did everyone else.
   

4. A frequent occurrence in volatile markets, panic is different from bubbles and requires a different response. Now dressed up with the modern name of “liquidity” crisis, a panic can erupt in any market at any time, even in the safest and highest-quality government bond market. One should expect it and be prepared—not to respond. One moment the liquidity of an investment is taken for granted, like the air we breathe; then for whatever reason something happens to shake that confidence, and suddenly liquidity is the only thing one can think of, like the loss of oxygen, and one does crazy things like selling for pennies what the day before was worth thousands. This is when rare individuals, like Baron Rothschild, did his buying, “when blood is running in the street.” Most of us are unable to see a panic as a buying opportunity, like the Baron, but at least we can resist selling at a ruinously low price. Panics tend to be short-lived. Thus, in almost all cases, it is best to do nothing in a panic.
   

5. There is an analog to bubbles and panics that can be every bit as destructive to capital formation, especially in inflationary times like the present: cash, whether in the mattress, a checking account or a fixed-income annuity. Over long periods of time, say 20 years, cash tends to lose the bulk of its purchasing power. Keeping a year’s worth of expenses in cash allows one to ride out panics and bear markets and is therefore not a bad idea; but any more is in the long run too costly, tantamount to the results of wild speculation, a slow-acting, self-inflicted wound.
   

6. The constellation of values that make up a stock price is what makes a particular stock attractive, not the industry the stock is in. Thinking otherwise is a short cut that can save the hard work of analysis (as in, “I am only going to look for and buy AI stocks”) but can wind up leaving you with a broken-down klunker of an investment bought at Ferrari-like prices. Why? Wall Street is expert at repackaging tired old businesses into phony versions of the glamorous new industry. But there’s another reason, more subtle but probably more powerful, to focus on the value proposition behind a stock rather than the industry it is in. The most reliable/least risky way to profit from an important new trend is through the firms and industries it helps the most. This truth is expressed in the oft-repeated accounts of who made the money at Sutter’s Mill in 1848; it wasn’t the gold miners. There is a more recent instance of this: after a brief boom in the late 1990s, the biggest beneficiaries of the Internet weren’t the pioneers (Cisco, AOL, Yahoo). Rather it was the industrial sectors that used the Internet to cut costs and expand their markets. Recently the Wall Street Journal ran an article asking what is the best way to invest in AI? (“Best Way to Bet on AI? Bet on the Whole Market?” WSJ, 3.17.24, p. 83). We agree with the recommendation. We like reasonably-valued stocks that already have independent reasons for owning them, for which an AI-driven investment cycle will be an additional tailwind, if the big predictions pan out. For example, we have been adding a position in Western Digital (WDC) across many portfolios. Western Digital makes data storage hardware (flash and hard disk drives). Quite apart from the AI craze, Western Digital is well-positioned: the flash and hard disk drive market has consolidated to a handful of players and Western Digital is one of the largest. Recently the company’s management committed to a corporate reorganization that will reverse an ill-considered acquisition that has in recent years caused the stock to trade at a discount to its peers. Furthermore, the industry is coming out of a painful hardware destocking cycle which has pressured its sales and pricing power. AI-driven investment, which requires huge investments in all aspects of data center hardware and not just semiconductors, is thus an accelerant to Western Digital’s recovery, but the stock will probably do quite well even if the AI boom fades more quickly than its prophets predict. The same can’t be said for semiconductor stocks that have already priced in a sustained AI revolution. Other stocks in many of our client portfolios are like Western Digital in offering less risky and perhaps more durable ways of participating in AI. Generative AI is only as good as the data that feeds it and a company that owns many of the most valuable and unique data sets available is S&P Global (SPGI), a longtime stock holding for many client portfolios. S&P earns high-margin, royalty-like income from licensing access to its unmatched historical and real-time information about financial markets, commodities, and automotives. Without access to reliable proprietary data like S&P’s, AI will remain more of a spectacle than a business tool. Another likely beneficiary of AI-driven hardware upgrades is our clients’ stock, Best Buy (BBY), the electronics retailer and home-tech services provider. Although inflation has crimped the middle-class consumer’s buying power, many of Best Buy’s electronics have become more like required staples than purely discretionary purchases, thanks to the adoption of remote work, mobile payments, and e-commerce. The AI investment in data centers will likely encourage a comparable upgrade cycle in consumer devices in order to support the roll out of energy and data-hungry AI applications. Best Buy’s services business (think of the “Geek Squad”) is also popular, has few competitors of a similar scale, and has allowed Best Buy to expand into new markets, such as the healthcare technology that supports older people “aging in place” at their homes rather than moving to assisted-living institutions. The company’s valuation is undemanding, trading with a price to earnings ratio of 13 and a 5% dividend.

My last appraisal letter to you (January 14, 2024) explained why high inflation over the long term, say the next 10 or twenty years, appears likely if not inevitable; why the current stock market rally, concentrated into a few stocks (the so-called Magnificent Seven) looks like an accident waiting to happen; and why accelerating geopolitical upheaval means the end of Pax Americana and the associated “peace dividend” enjoyed over the past 30 years. In terms of investments we like, I explained why our portfolios are heavy in Treasury bills, energy, and building materials, and light in bonds, banks and commercial real estate. We still believe this. For the full argument for the respective positions, readers should refer to our website, where all recent appraisal letters are available. But to summarize our position: The governments of the developed world including the United States have set to “maximum” monetary and fiscal stimulus, and this is unlikely to change in an acrimonious election year. This is not what they are saying but it is what they are doing. A reckoning in terms of higher inflation and perhaps shaky stock and bond prices is likely after the elections in the third quarter. Until then, in the words of a colleague here at O’Brien Greene, it is party on. The overall and long-term condition of the economy and markets reminds me of the 1970s when I began my investment career. Inflation is the enduring predisposition of democracies, and it is back. There are still compelling reasons to stay invested, as there were in the 1970s, but there are also reasons to seek out lower-risk ways of staying invested than currently popular. In a few words: be cautious, control what you can control to avoid the self-inflicted investment wound, and remember, as Lincoln said, America is still the last best hope.

Sincerely,

Mark O’Brien

1. One of my favorite authors, Samuel “Dictionary” Johnson had this to say on the need to reinforce, frequently, what we already know, or think we do: “…it is necessary that our minds be enlightened by frequent repetition of the instructions which if not recollected, must quickly lose their effect.”

Important Disclaimer: Past performance and yields are not indicative of current and future results. There is the possibility of loss of principal with any investment. The views expressed are the views of O’Brien Greene & Co. authors as of the date of the date indicated and are subject to change at any time without notice based on market and other conditions. Its content does not consider any individual investor circumstances, objectives or needs. Any specific securities or asset allocations mentioned may not be included or implemented in specific investor’s account due to the unique circumstances involved in managing each investor’s financial situation. O’Brien Greene & Co. has no duty or obligation to update the information contained herein. The information is for informational purposes only and should not be used for any other purpose. Certain information contained herein concerning economic data is based on or derived from information provided by independent third-party sources. This is not an offer or solicitation for the purchase or sale of any security and should not be construed as such. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. O'Brien Greene & Co. may have positions in the securities mentioned in the commentary provided on this site. Investment decisions should be made based on each investor's objectives, liquidity and risk profile and complete financial situation. Many investments are unsuitable for certain individuals, and investors should consult a professional before acting. Investor should ensure that they obtain all available relevant information before making any investment.